The New SEC Auditor Independence Rules: Implications for Audit Committees and Management

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SEC Final Rule

On January 28, 2003 the SEC issued their final rules on auditor independence as required by the Sarbanes-Oxley Act of 2002.

“Strengthening the Commission’s Requirements Regarding Auditor Independence” (97 pages).

Effective Date: May 6, 2003

Scope of Services Provided by the Auditor

Three Significant New Restrictions

1. A prohibition on financial information systems design and implementation services.

2. A prohibition on internal audit outsourcing services.

3. A restriction on certain types of “expert” services.

Other Prohibited Non-Audit Services

Bookkeeping

Appraisal or valuation, fairness opinion, or contribution-in-kind reports

Actuarial services

Management functions

Other Prohibited Non-Audit Services

Human resources

Broker-Dealer

Legal services

Pre-Approval of Audit Services

Pre-Approval of Services

The Act specifies in Sections 201(b) and 202 that all audit and non-audit services provided by the independent auditor must be pre-approved by the audit committee.

Disclosures to Investors

Disclosures to Investors

Section 202 of the Act requires that issuers disclose in periodic reports and proxy statements non-audit services performed by the auditor.Audit FeesAudit-Related FeesTax FeesAll Other Fees

Hiring Members of the Audit Engagement Team

Hiring Rules

Section 206 of the Act requires a one-year cooling-off period before audit engagement team members will be able to accept employment at the issuer in a “financial reporting oversight role.”

Financial Reporting Oversight Role

Those persons exercising or in a position to exercise influence over the financial statements, and anyone who prepares those statements.

Member of the Board

Chief Executive Officer

President

Chief Financial Officer

Chief Operating Officer.

Financial Reporting Oversight Role

General Counsel

Chief Accounting Officer

Controller

Director of Internal Audit

Director of Financial Reporting

Treasurer, or

Any equivalent position.

Example for Calendar-Year Company

In this example, a 2002 audit team member covered by the rule could not be hired in a financial reporting oversight role position prior to March 23, 2004.

Files its 2001 Form 10-K

Files its 2002 Form 10-K

2002 Audit Period

Cooling-Off Period for 2002

Audit Team

March 15, 2002 March 22, 2003 March 16, 2002 Through March 22, 2003

Ends March 23, 2004

Audit Partner Rotation

Audit Partner Rotation

Section 203 of the Act limits both the “Lead Auditor” and the “Concurring Partner” to a maximum of five consecutive years in those roles.

They are then required to rotate off for at least five years.

Audit Partner Rotation

Lead PartnerConcurring or

Reviewing PartnerOther Engagement

Team Partners

Five Consecutive Years On

Five consecutive years on

Seven consecutive years on

Five-year time-out Five-year time-out Two-year time-out

Communications

Communications

The SEC, under Section 204 of the Act requires the independent auditor to make certain timely communications to the audit committee.

Communications

All critical accounting policies and practices to be used.

All alternative treatments with GAAP for policies and practices related to material items that have been discussed with management.

Other issues material to the financial statements.